Why Credit Card Rates Remain So High

By AnnaMaria Andriotis

Interest rates have been driven down on everything from bank accounts to mortgages. But new data shows borrowers still pay double-digit rates on one consumer staple — credit cards.

The average interest rate credit card holders paid during the fourth quarter 2011 was 12.78%, according to Federal Reserve data released today. That’s down from 13.08% during the previous quarter and 13.67% a year prior. Despite the declines, the latest data underscores that credit cards remain one of the most expensive forms of financing. By comparison, the average rate on new car loans is about 5% while 30-year mortgages are down to about 4.2%.

Banks say consumers will continue to see higher interest rates on credit cards than on other loans because they are riskier products. “The lender has to be compensated for the risk they’re assuming,” says Keith Leggett, vice president and senior economist at the American Bankers Association. Car loans and mortgages are considered less risky because they’re tied to actual collateral, he says.

Credit card rates are determined by several factors. They’re pegged to the prime rate, which has been 3.25% since 2009. Then card issuers tack on a margin, which was 9.53 percentage points in November, according to the latest data available, down from 10.42 in November 2010 and 11.12 in 2009. Issuers determine the margin based on the economy: High unemployment rates and bleak financial outlooks typically result in a higher margin as the lender prices in the likelihood of borrowers losing their jobs and missing card payments, says Odysseas Papadimitriou, chief executive at CardHub.com. (By comparison, in May 2000, the average margin hit a 20-year low of 5.52 percentage points; the unemployment rate that month was 4.0%.)

Also impacting their rates is that unlike other loans, credit cards aren’t necessarily paid down over time, says Dennis Moroney, research director of bank cards at TowerGroup. Instead, they’re moving targets allowing for debt to rise or drop at the borrower’s discretion.

Of course, a borrower’s profile also determines the rate he or she pays. Borrowers with high credit scores – typically above 720 — and with low debt-to-income ratios have the best shot at landing the lowest rates, says Papadimitriou. For those borrowers, some cards stand out among the competition. The First Command Bank Platinum Visa, the First Federal Bank, and the IberiaBank Visa Classic credit cards have interest rates of 6.25%, 7.15% and 7.25%, respectively.

Borrowers paying high interest rates on a credit card balance might want to consider transferring that amount to a new credit card. Many cards are touting 0% promotional rates on balance transfers that last nearly 10 months on average, based on fourth quarter 2011 data from CardHub.com, up from nearly 7.5 months a year prior.

Experts say the best way to save money on credit cards is to pay the balance off in full each month. Or in the case of 0% promotional periods, to pay the balance off in full before that term ends. That way, regardless of the card’s interest rate, the borrower doesn’t incur that charge.

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